Tuesday, November 22, 2005

Advantages of being a small investor 6 comments

(P.S: Sorry for any disturbances the advertisements above may have caused you)
Only when one knows his strengths and weaknesses can he excel. That is as true in investing/trading in the market as in any other aspect of life.

What are the advantages of being a small investor, with the obvious comparison case being that of the big institutional holders (ie. the funds, the market makers, the brokers, the substantial shareholders). One point I must debunk is that small investors can look around their neighbourhood and buy into popular consumer brands or companies, Peter Lynch's so-called "shopping mall" approach. Come on, institutional analysts do that full-time, and even have access to top management, plant visits and most recent quantitative numbers on trends; surely it would be Institutions 1 Small investors 0 on this score? I have no doubt small investors are at an information disadvantage, generally. And don't get me started on the price manipulation big money is capable of generating, to its benefit.

The main advantage of being small is that there is no need for an entry or more importantly, exit strategy. Big holders will find it difficult to dispose of a large line of shares, since shares also follow the law of supply and demand: high supply --> prices drop. That's why institutions are typically less adventurous in their stock picks, and exhibit herding behaviour ie. buy similar stocks. Small investors can venture into less liquid stocks, buy it up without much price impact, and also dispose of their line relatively quietly. Big holders have to sell into strength, small holders can sell upon decline of strength; usually the price at the later stage is higher than the earlier mentioned stage.

The second advantage small investors enjoy is the freedom and flexibility in their stock picks, their asset allocation, their execution of snap buy and sell decisions. I am not sufficiently familiar with the operations of fund managers, but I expect there would have to be some quantitative analysis done, some discussions, approvals etc before major accummulation or disposal of a position is executed ie. there is red tape. More importantly, many funds, in particular unit trusts, are bound by their charter to buy a particular class of stocks. For example, a Japan growth unit trust is only allowed to buy Japan growth stocks, even if the country outlook is foggy. That means stock picking horizon is artificially fenced. Most fund managers also are compelled to stay fully invested ie. minimal cash holdings; that means asset allocation is artificially constricted. The individual investor acting alone can make his own calls; he should stay that way and not his decisions be influenced by others' comments, only by facts.

The third advantage is that motivation level is higher. The small investor is investing his own money, and lives and dies by his calls. The average fund manager's motivation might well be to attract more money into his fund so that his cut (from the fund expense ratio) will be larger. The fact that making money for the portfolio is a means to an end (ie. attracting new funds) instead of an end in itself (as it is for the small investor) creates different mental paradigms. For new investors to be attracted into the unit trust, a steady track record is preferred and the fund manager consequently adopts a conservative strategy aiming to smoothen volatility (ie. buy blue chips) instead of maximising returns. We often have a situation of fund managers herding around a few market favourites. The rational small investor, on the other hand, might take advantage of market pessimism to buy into a certain sector and position himself for the future recovery. He is answerable to no-one (except maybe his family) and all profits (and losses) accrue to him. There is no more powerful motivator than self-interest (augmented by an appetite). That's why I don't like to dilute that motivation through managing money for other people eg. relatives; I lose focus and the profits don't flow to me!

One will notice that the abovementioned advantages for the small investor are mainly attributes of speed. That is true, it is indeed my point. In role-playing parlance (pardon me, those non-fans of RPGs) the institutions are the Fighters with great endurance and strength attributes (by virtue of their big money), while the small investors are the classic Thiefs, with excellent speed and dexterity. This is not a call for small investors to trade in and out of the market; far from it, for the frictional costs (commissions) are high for small trades. Rather, my point is that buy-and-hold is what the big institutions advocate because that is what they can only do, given the size of their holdings. The small investor should watch his opportunity, buy decisively and also dispose decisively when valuations are fully realised, while not following any rigid rules and possessing the flexibility to adapt to market momentum. That will truly be leveraging on the strengths of being a small investor.




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11/22/2005 11:32 AM  
Anonymous Anonymous said...

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10/02/2006 11:39 PM  
Blogger DanielXX said...

Thank you :-) I'm flattered.

10/03/2006 9:51 PM  
Blogger ecgwee said...

thanks for sharing

10/21/2006 10:15 AM  
Anonymous Anonymous said...

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2/22/2008 3:49 AM  

Oh yes small is beautiful.

1/14/2014 10:52 AM  

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